Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Albert David Limited (NSE:ALBERTDA), by way of a worked example.
Over the last twelve months Albert David has recorded a ROE of 9.4%. That means that for every ₹1 worth of shareholders' equity, it generated ₹0.09 in profit.
See our latest analysis for Albert David
How Do I Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for Albert David:
9.4% = ₹198m ÷ ₹2.1b (Based on the trailing twelve months to June 2019.)
Most know that net profit is the total earnings after all expenses, but the concept of shareholders' equity is a little more complicated. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders' equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
What Does ROE Mean?
ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the amount earned after tax over the last twelve months. The higher the ROE, the more profit the company is making. So, as a general rule, a high ROE is a good thing. That means it can be interesting to compare the ROE of different companies.
Does Albert David Have A Good Return On Equity?
Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. If you look at the image below, you can see Albert David has a lower ROE than the average (13%) in the Pharmaceuticals industry classification.
Unfortunately, that's sub-optimal. We'd prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Still, shareholders might want to check if insiders have been selling.
Why You Should Consider Debt When Looking At ROE
Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Combining Albert David's Debt And Its 9.4% Return On Equity
Although Albert David does use a little debt, its debt to equity ratio of just 0.0021 is very low. Its ROE is rather low, and it does use some debt, albeit not much. That's not great to see. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.